Are we heading towards an economic collapse? Ten thoughts on macro and crypto

Original author: rektdiomedes
Original compilation: Jaleel, BlockBeats

On June 15, Federal Reserve Chairman Jerome Powell delivered a speech: "Today, we decided to keep our policy interest rate unchanged and continue to reduce our securities holdings." At the same time, Powell also stated that further rate hikes this year would be appropriate to bring inflation down to 2%.

After nearly a year and a half of rate hikes, the Federal Reserve has finally paused. We are currently in a truly fascinating macro environment, and I have some crazy thoughts about the macro economy and crypto…

1: Economic performance far better than expected

I can't think of any macro commentator 18 months ago who believed the Federal Reserve could raise rates to such high levels without completely blowing things up, but paradoxically, the economy seems to be thriving (at least so far).

2: The huge impact of increasing U.S. government fiscal spending

I believe the ultimate lesson from this rate hike cycle may be that the Federal Reserve is increasingly powerless to overcome the impact of the U.S. government's massive and growing fiscal spending.

TheHappyHawaiian (@ThHappyHawaiian) believes that 2023 is the year of the U.S. deficit explosion. In the first five months of 2023, the deficit reached an astonishing $743 billion, a 1416% increase from 2022, with $49B as of May. Revenue: $1,969B compared to $2,323B (-15.3%); Expenditure: $2,712B compared to $2,371B (+14.4%). In short, revenue is down, and spending is up.

Image source: @ThHappyHawaiian

As Kuppy (@hkuppy) and Luke Gromen (@LukeGromen) have pointed out, the Federal Reserve paying 5% on Treasury bonds has ultimately acted as a stimulus in its own way, as all the excess funds from the government's drunken spending still flow into the economy, just in a different manner compared to ZIRP and QE.

In fact, the remainder of this decade seems to be just an increasingly creative dance between the Federal Reserve and the Treasury: how to monetize our ever-rising budget deficit/sovereign debt. As Captain Rational @noahseidman believes: if the Federal Reserve does not fund the Treasury's capital raising, Congress will eventually be forced to instruct the Treasury to print money directly based on the state of the bond market and balance sheet pressures (income vs. capital expenditure) rather than borrowing.

3: We are in a new era of structurally low unemployment

This hiking cycle also seems to provide a lesson that we are in a new era of structurally low unemployment, primarily due to demographics (the entire baby boomer generation retiring + a sharp decline in birth rates in the U.S. and globally over the past 40 years)… Today marks the longest period of unemployment below 4% since the 1970s.

Image source @LizAnnSonders

Clearly, the official unemployment rate is a somewhat tortured data point, but there is no doubt that due to demographic and social factors, labor demand is continuously increasing, and wages (naturally) are rising for the first time in 40 years.

4: The risks posed by vacant properties are brewing

The vacancy rates in commercial real estate (especially offices) look absolutely dreadful, not just because of the obvious high rates resulting from equity destruction but also because everyone is turning to remote work. According to data from The Kobeissi Letter @KobeissiLetter, the office vacancy rates by city are as follows:

Currently, 17% of all office space in the U.S. is vacant. Meanwhile, over $1.5 trillion in commercial real estate debt will mature by 2025. Most of this debt is held by regional banks, and vacant properties are struggling to repay their debts. This is a brewing crisis.

5: Remote work will continue to exist

It is becoming increasingly clear that cubicle offices are completely out of touch today. More importantly, there has been a widespread cultural shift from "preference for remote work" to a heartfelt hatred of working in an office. Working from home is becoming a huge political issue, with many people viewing working in an office as a deprivation of freedom. This is a topic that people are very passionate about, akin to religion/politics. This movement is much stronger than many realize, especially among the younger generation.

We can hardly overstate the significance of this transition to remote work. For over 150 years, during the industrial and office eras, the U.S. has been defined by a massive economic migration to cities, which can be said to represent a 180-degree turn in the opposite direction.

6: The impact of the debt ceiling resolution/TGA replenishment

I believe the big question in the short term should be what impact the debt ceiling resolution/TGA replenishment will have on liquidity conditions and risk assets.

There is no doubt that the consensus is bearish, but I believe the following topic from Conks (@concodanomic) offers a more nuanced view on this issue: So far this year, the liquidity-driven rebound has pushed the S&P 500 index up 12%. But now, the next major "liquidity drain" is about to begin. The latest political drama ended with a pause on the debt ceiling until 2025, allowing monetary leaders to restart the printing press. For the remainder of 2023, the U.S. Treasury is now prepared to issue about $1 trillion in net notes to the most systemically important markets…

If history repeats itself, officials aim to fill the U.S. government's bank account, specifically the Treasury General Account (TGA) within the Federal Reserve system, with about $600 billion before September. The TGA holds the universal key to every commercial bank's Federal Reserve account and will slowly accumulate reserves. The consensus focuses on two impacts of "TGA replenishment": the large issuance of government debt leading to market instability, and the subsequent loss of bank deposits and reserves leading to reduced liquidity. However, the outcomes of both are not as dire as they seem.

Firstly, it is believed that issuing such a large amount of Treasury bonds in a short time will be difficult for the market to absorb, thus widening spreads and causing turmoil. But as history shows, the bond market absorbs large issuances without much trouble, even within a month. As for demand, with yields reaching their highest returns in decades, coupled with the ongoing shift from unsecured (LIBOR) to "secured" (SOFR) benchmarks, the world is eager to absorb the U.S.'s increasing debt burden. Financial giants are hungrier than ever.

Referring to the Federal Reserve's latest survey of its primary dealers, we also know in advance that major market participants are willing to consume large amounts of sovereign debt, with the Federal Reserve authorizing specific entities to make markets in U.S. Treasuries. Expected supply matches demand. Conversely, what affects liquidity is not whether market participants can absorb trillions of dollars in newly issued Treasuries, but who buys most of the issued Treasuries. What is truly concerning is the subsequent loss of liquidity in the banking system.

The most optimistic liquidity scenario is if most Treasuries are purchased with cash stored primarily by money market funds (MMFs) and some banks in the Federal Reserve's RRP (reverse repurchase) tool. Considering regulations and risk versus return, most of the excess cash will ultimately flow here…

The Federal Reserve's recent silence has added to the rebound of risk assets. More importantly, the market may have already anticipated the "blackout period," which currently limits the ability of FOMC staff to speak publicly or take questions. The temporary pause has reached maximum effectiveness.

7: Energy supply situation remains unresolved, prices are a major variable

Similarly, in the medium term, energy prices seem to remain a major variable worth watching, as they are potential factors that could start driving inflation back up. Lyn Alden, founder of Lyn Alden Investment Strategy (@LynAldenContact), believes: if you look at commodity capital expenditures, sovereign bond bubbles, global friction, the rise of populism, and the inability to cut spending, you might think this is cyclical deflation within a long-term structural inflation trend (temporary demand destruction). Currently, inflation is on a downward trend (deflation), and I expect inflation in many categories to persist, but remember that the energy supply situation remains largely unresolved and is likely to become a driving force in the next inflation cycle.

8: On-chain DeFi and Bitcoin are still rapidly developing

Crypto has been thoroughly beaten down over the past year and a half. However, on-chain DeFi and Bitcoin are still rapidly developing, and anyone seriously using Tradfi and on-chain Rails will realize that on-chain Crypto is 100 times more efficient.

9: Crypto still needs a lot of innovation

That said, cryptocurrency still seems premature and requires a lot of innovation—especially in terms of privacy and user experience, such as enabling normal things like payroll, AR/AP, etc., to be fully on-chain.

10: The arc of economic history will turn towards cryptocurrency

For the remainder of this year, most of the risks in cryptocurrency seem to be specific (regulatory, Binance, Tether, etc.). All liquidity and capital have left this space, making it hard to see any macro contagion having too dire an impact on it.

But in the long run, as generational cycles progress, I see no reason why the arc of economic history would not turn towards cryptocurrency, as even its critics acknowledge that it attracts a significant amount of intellectual capital, and I do not know of any other successful young people who are not optimistic about it.

Conclusion

Although the Federal Reserve has achieved apparent success in raising interest rates and curbing inflation, it may seem futile when narrowing the scope in the coming years. The U.S. still has the same massive debt: the GDP ratio and the unfunded baby boomer entitlement issue, and the past 18 months are likely to ultimately resemble the famous "Weimar Germany gold" chart, plummeting dramatically: